What Do Payday Loans Cost Caps Really Mean For Borrowers

The following article is from Mary Butland. She is a finance blogger and freelance writer who produces articles for some of the UK’s most authoritative sites. When she’s not hammering away at her keyboard, Mary is a keen balloon artist and amateur baker.

Good news at last. I’m sure by now the majority of you will have heard that the Financial Conduct Authority (FCA), the payday loans industry regulator, has proposed cost caps that, if accepted, will limit the cost of a payday loan.

Following their announcement in July 2014, the proposals are now in the consultation period, before coming into force on 2 January 2015. The details of the caps are threefold. Firstly, they limit the interest and fees on new payday loans, and loans rolled over, to just 0.8 percent of the amount borrowed. Then there’s late payment fees, which cannot exceed £15. Finally, the total amount of fees and interest an individual will have to repay will never exceed the original value of the loan. In practice, this means that a £100 loan from a payday lender like Wonga will never cost more than £200 to repay.

These are not the only recent developments in the payday loans sector. New rules which came into force on the 1 July this year prevented payday lenders from rolling over loans more than twice and restricted their ability to use continuous payment authority to take money directly from customers’ accounts. Alongside the cost caps, this may sound like the answer to the problems some people have experienced with payday loans, but unfortunately, it might not be that simple.

The potential problems with cost caps

On the face of it, cheaper payday loans can only be good news for borrowers. Debt spirals will be a thing of the past and consumers will understand precisely how much a loan could cost them before they agree to the loan. The caps may not be such good news for lenders, who it is estimated will lose 42 percent of their £1 billion revenue a year, but the major players in the industry should still be able to operate at a profit.

However, the implications of cost caps run more deeply for those most in need of short-term credit. The real problems will be experienced by those who have been turned down for loans from other lenders due to their poor credit records. While the payday lenders could take on risky loans in the past thanks to more generous profit margins, they may now have to turn down loans from those most in need. This will leave the most vulnerable in our society with nowhere to turn other than criminal loan sharks.

The popularity of payday loans

In the last year alone, 1.6 million consumers have taken out payday loans worth a total of £2.5 billion, with each customer receiving an average of six payday loans over the course of a year. The average loan amount was £260, borrowed over an initial period of 30 days.

Once the new price caps are in place, the Financial Conduct Authority estimates borrowers will save an average of £193 over the course of the year. This will result in total annual savings of £250 million and will represent £420 million in lost revenues for the lenders.

Unfortunately however, it is these lost revenues which may force lenders to reject borrowers who present a risky lending proposition. Currently, there is no viable or legal lending alternative to handle this overspill. As not-for-profit organizations, credit unions charge an average APR of 3 percent. This gives them little leeway to lend to those who may default on their loan, resulting in more conservative lending decisions than those made by the payday lenders.

A spokesperson for the comparison and switching service uSwitch, said: “Payday lenders have an important role to play in providing short-term credit and our research shows that over half of all customers who have taken out a payday loans say the experience was positive.

“However, it is important that the issues around the lack of adequate credit checking and providing support to those who end up in financial difficulties are addressed.”

The Consumer Finance Association which represents the payday lenders, said: “With new regulations and tighter affordability checks, critics must now face up to the fact that more people use, need and like short-term credit and the measures in place are more stringent than for any other form of consumer credit.”

Do you agree that the proposed cost caps will make payday loans a highly affordable source of short-term credit? On balance do you think the cost caps are good or bad for consumers? Please leave your thoughts in the comments section below.